Do you really need an emergency fund?

For years, financial writers have parroted the conventional wisdom that people need an emergency fund equal to three to six months' worth of living expenses in a safe, liquid account.

Like most such rules, that formula seems due for a closer look.

For one thing, bank savings and checking accounts, the first places most of us consider for our emergency cash, are paying such paltry rates that they might not seem worth the bother. The average savings account is yielding a mere 0.08 percent, according to the latest Bankrate survey, while the average interest-bearing checking account ekes out 0.05 percent.

Savings on a treadmill

Meanwhile, inflation is running about 1.6 percent, as measured by the Consumer Price Index. As a result, money in so-called "safe" accounts is not only gaining very little, but is also actually losing ground every year. And that hypothetical emergency we're worried about could be years away -- or never happen at all.

At the same time, people who lose their jobs tend to be out of work much longer than three months -- 37.1 weeks on average, according to the Bureau of Labor Statistics. From that perspective, even six months, or 26 weeks, of living expenses seems far from adequate.

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So what's a person to do -- just give up on the whole idea and hope for the best? Probably not.

Fortunately there are some relatively simple ways for you to protect yourself. Being adequately prepared for a financial emergency doesn't require that you keep all your money in low-yielding savings vehicles. You'll need some money there, of course. But beyond that, you'll want to make sure you have other financial resources at your disposal.

You might think of it as your emergency fund plus your backup emergency resources. Here's some advice on each.

Assess your situation

All of us need some easily accessible cash to cover unexpected, but not all that rare, expenses like a big car-repair bill or visit to the emergency room.

Just how much you'll need to put aside depends on a number of personal factors, says Mari Adam, a Certified Financial Planner in Boca Raton, Fla. For example, if you're part of a two-earner couple, you might not require as much as if you were on your own. If you're adequately insured, as you should be anyway, you might not need as much as if you're not.

It's worth remembering, too, that if you lose your job, you'll most likely be entitled to weekly unemployment insurance benefits. That's rarely enough to live on, but it does provide some cash flow for 26 weeks in most states and longer in some others. Congress has not yet extended benefits for the long-term unemployed at this writing.

Adam also suggests taking a hard look at your current spending habits relative to your income. The more you live within or even under your means, the better equipped you are to face a financial emergency. "We've seen people with considerable assets and income run into trouble because their overhead is too high and they spend everything they make," she says. "They might make $500,000, but they spend every cent."

Your emergency fund

Greg McBride, chief financial analyst with Bankrate.com, maintains that most of us should probably aim for that fabled six months' worth of expenses -- though he acknowledges that only about a quarter of all Americans have reached it, according to a recent survey by Bankrate. In fact, he suggests that after you've put that much away in safe, liquid accounts, your next step should be to save additional funds in other, only slightly riskier investments, such as dividend-paying stocks.

So where should you put your "safe" money? Nowhere terribly exotic.

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Do you really need an emergency fund?

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An action plan for your emergency fund. Don't say we didn't warn you.

Just how wise is the conventional wisdom that suggests most people need an emergency fund equal to three to six months of living expenses in a safe, easy-to-access account?

There's no denying that savings accounts haven't paid out much in the wake of the Great Recession. Even though many people tend to be unemployed longer since the financial crisis, an emergency savings plan is still considered part of personal financial best practices. If you are part of a two-income couple, that's an added bit of insurance as long as the other person is working. And while unemployment benefits are often an option, they don't last forever, and it might not provide as much as you'd earn on the job.

Other resources you can tap as last resorts include: mutual funds and other investments, Roth individual retirement accounts and even a home equity line of credit. With a 401(k) plan, you might be able to take a hardship distribution or loan. But those can also present challenges with either taxes owed, or paying back the loan in full if you leave your job.

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